While we recognize that in 2013 we enjoyed significant outperformance and 2014 brought some partial consolidation of those gains as we faced significant headwinds against our portfolios, as a rule we place little weight on short-term results, good or bad. And, we believe, neither should you. Our portfolio decisions are driven by what we believe will mitigate risk and improve our opportunity for long-term returns. We encourage you to place more weight on our longer-term historical results, and a great deal of weight on our long-term prospects. In that light, we’d like to say thank you to our clients: Your patient capital allows us to take advantage of opportunities when they occur when others are forced to sell at exactly the wrong time. We truly value and are grateful for you, and we believe that patient capital will be rewarded over the long term.

Speaking of the long-term view, we do bear in mind that the economy of the 19th and 20th centuries got us a long way, propelling the global economy to where it is today. But from here, looking forward, it’s clear that this legacy economy is fraught with systemic risks, not the least of which are the worst effects of climate change and global resource scarcity. Particularly now that there are 7.3 billion of us, with many enjoying rising affluence and standards of living, our economic activities, for the first time in human history, if not the history of Earth, can and do have real impact. So, unless we want our own self-caused biggest threats to come home to roost, it’s time, or even past time, to change the way the economy works. So, we at Green Alpha think it is time to change where capital is deployed. As long as we remain invested in the fossil-fuels based legacy economy, we’re going to get increasingly strong storms, acidic, rising seas, diminishing biodiversity, and all manner of risks from an increasingly warm planet. These are the material, long-term risks we invest to avoid and mitigate.

Meanwhile, in the shorter term, 2014 proved substantially more volatile -– especially in the downward direction -– for most Green Alpha portfolios than did 2013, and concerns about performance are valid, although we believe that most of our clients understand the long-term nature of our thesis. In 2015 and beyond, we expect our Next Economy companies will continue to gain market share from their legacy economy predecessors, and therefore continue to have outstanding chances for competitive long-term performance. But emerging methods, solutions, and technologies take time to be recognized, and they can have unfortunate market performance even as their underlying businesses are booming.

In 2014 (off and on), geopolitical events such as perceived slowing in China's economic growth, further slowing and even deflation in Europe, social and political unrest around the globe, and pandemic fears, among others, caused a general shift away from growth stocks to more traditional value stocks. Anything thought of as high momentum or high growth was sold in favor of more traditional blue chips; here we cite that the Dow Jones Industrial Average was relatively competitive all year. Of course, the possibility exists that this trend may continue, but the possibility equally exists that the shift may have run its course and that now investors will begin to hunt for bargains among the growth stocks that have pulled back. Either way, the point is that stocks with good fundamentals (and working in rapidly growing areas -- like the solutions to society's most pressing systemic threats) are not declining due to company-integral issues, but rather are being caught in generalized negative market sentiment. This presents market inefficiencies that diligent work may uncover.

Some, such as Naomi Klein, have suggested that to reach a point of truly indefinite sustainability, human economies can no longer be characterized by growth, but rather by a circular state of dynamic equilibrium wherein waste-to-value economics and renewable energies are distributed equitably and repeatedly. This is as may be, and our own philosophy of next economics does share some principles with this vision. But in reality, the global human economy is so far from realizing this ideal, that not just some but all of our best ideas and solutions from every sector that advance sustainability have every opportunity to and indeed must grow rapidly. As we, step by step, come closer to realizing a world wherein human economies and our underlying ecosystems may persist side by side for a very long time, the end of growth may be here for some legacy industries like fossil fuels, but it is still a long way off for the providers of solutions to our key systemic risks.

Yet it's unavoidable that Green Alpha’s portfolios get caught up in short-term market volatility like a general downdraft for perceived growth equities like we experienced in 2014. But we believe that by carefully selecting growth and value stocks with great fundamentals, we are building portfolios that stand every chance of being early to recover, and on that basis we consider the inevitable times of market consolidation to be attractive entry points within our methodological approach.

We managed five separate account strategies for the entirety of 2014: Green Alpha Next Economy Index (or GANEX), the Sierra Club Green Alpha Portfolio (SCGA), the Green Alpha Select Solar Portfolio (GASSP), the Green Alpha Growth and Income Portfolio (GAGIP) and the Green Alpha Enhanced Equity Income Portfolio (GAGEEIP). We are also sub-advisors to the Shelton Green Alpha Fund (ticker: NEXTX). The full year 2014 and 2013 returns for each were (source, Bloomberg Finance L.P., returns net of fees):

Portfolio 2014 Return 2013 Return

GANEX: -4.79% 63.51%

SCGA: -2.76% 99.79%

GAGIP: -1.98% 32.87%

GAGEEIP: 3.91% NA

GASSP: -20.97% NA

NEXTX: -1.48% 48.40%

One primary source of portfolio volatility in 2014 was our exposure to renewable energies, which, inappropriately in our view, have been selling off along with oil since mid-2014. We think it’s important to remember that solar is a technology (as, to a slightly lesser extent, is wind), and its past and future cost dynamics will look like technology -– becoming ever cheaper. Fossil fuels are commodities – finite and expensive to locate, extract, refine and ship -– and fossil fuels have had and will have cost dynamics to match: very volatile. In the long run, 10-20 years from now, as our economy and infrastructure can make more and better use of renewables, the two will compete directly in a way that they do not now, but by then renewables, led by solar, will be so inexpensive that the cost comparison will no longer spark argument. So different are the commodity and technology means of deriving energy that we at Green Alpha have proposed that they be classified as different industries within the energy sector altogether. The decline in solar prices in tandem with declines in the oil price is fundamentally not warranted and presents another exploitable inefficiency.

While we do take advantage of this volatility, we don't manage our portfolios to short-term factors. We focus not on what is important this month or this quarter, but on things that are fundamentally true, always -- things such as mitigating resource scarcity and adapting to the effects of climate change.

Due to many of the factors discussed above, we believe we are likely to see a transition in the market back to what many refer to as a stock picker’s market. To put a bit more context around this, Furey Research, a leading small cap research firm, recently reported that during the third quarter of 2014, small cap stocks, as measured by the Russell 2000 Index, underperformed the S&P 500 by 850 basis points (8.50%), ranking it among the worst relative performance quarters since the first quarter of 1979. As a result of the recent large cap run, small cap valuations have compressed and the gap between the rate of earnings growth for the S&P 500 and the Russell 2000 has widened, significantly in favor of small caps and the smaller mid-caps. While we expect continued near-term volatility to continue, we believe that stock selection will be a key driver of relative performance going forward, particularly as small and mid-cap growth stocks remain cheaper than their larger-capitalization counterparts. As a result, we believe that when market sentiment turns back toward favoring growth and tech, our portfolios can recover early and rapidly in relative terms because we work hard to invest in promising growth at good valuations -- companies with strong fundamentals.

From our perspective, the S&P 500 could be considered riskier than our mutual fund, the Shelton Green Alpha Fund (ticker: NEXTX), as it encompasses far slower-growing firms at richer valuations. Within NEXTX, the weighted average price-to-book ratio is 2.22, below that of the average S&P 500 stock, which is 2.79. NEXTX's EPS growth rate is 76.92% for the forward year, some eight times faster growth rate than that offered by the S&P 500 average EPS growth at 8.76%. (Figures as of 12/31/2014, data from Bloomberg Finance L.P.) We believe NEXTX represents a good intersection of growth at a reasonable value, and the recent pullback has only made that more true.

The combination of good firms, in rapidly growing sectors, with large scalability and margin profitability, that simultaneously are addressing one or more of the great risks confronting the global economy, is a powerful nexus of catalysts for long-term investors.

2015 and Beyond

So, where do we see opportunity? Well, at its heart, our approach to investment management is deceptively simple: Don't invest in the causes of our primary systemic risks, notably fossil fuels, and do invest in the solutions to those risks. For every function provided by the legacy economy, we believe there already is or soon will be a sustainable, Next Economy equivalent that is often far better than its legacy economy predecessor. So we strive to build a portfolio of Next Economy analogs for legacy economy functions. In addition to hopefully serving and advancing the cause of sustainability, this also turns out to be an effective equity growth strategy because it means investing in disruptive innovation and also in rapidly advancing economic efficiencies, meaning getting more and more dollars out of less and less economic inputs. This in turn allows us to have less and less impact on our underlying ecosystems, all while generating wealth. Thus our approach to economics and investing can become a sustainable, virtuous cycle. We believe we live in a time of nonlinear, even geometrically rapid change, and the innovations emerging now will allow us to have great standards of living, while also giving our underlying ecosystems a chance to begin recovering.

The portfolios where we put this thesis into practice follow.

Portfolio Products:

GANEX:

The Green Alpha Next Economy Index (GANEX), launched December 30, 2008, is our most comprehensive portfolio. GANEX includes companies that meet our Next Economy criteria –- sustainable, innovative, and growth-oriented companies from all sectors seeking to mitigate or innovate around climate change and resource scarcity. In 2014, GANEX was invested in 82 companies in 24 sectors. The top performers in 2014 were:

Sierra Wireless, Inc. +96.07%

SunEdison, Inc. +51.72%

Tesla Motors, Inc. +47.90%

Applied Materials, Inc. +43.63%

American Water Works, Co., Inc. +35.63%

Similar to 2013, GANEX’s industry diversification continued to include water desalination, waste-to-value building materials, machinery, electric vehicles, mobile communications and machine-to-machine Internet, energy efficiency and lighting, and wind power.

SCGA:

The Sierra Club Green Alpha Portfolio, launched December 27, 2010 continues to reflect Green Alpha Advisors’ Next Economy universe and the Sierra Club’s proprietary environmental and social investment guidelines. With 34 stocks in the portfolio, it is a more concentrated product, yet has investments in 16 industry sectors. Best 2014 performers were:

Sierra Wireless, Inc. +96.07%

Tesla Motors, Inc. +47.90%

SunEdison, Inc. 46.36%

Kandi Technologies Group, Inc. +18.83%

SunOpta, Inc. 18.38%

GAGIP:

The Green Alpha Growth and Income Portfolio, launched October 8, 2012, is designed for growth and income-oriented investors seeking lower volatility and also higher income than other Next Economy equity strategies, and holds 31 securities in 15 sectors. 2014 top performers included:

Applied Materials, Inc. +43.60%

American Water Works +31.79%

Brooks Automation, Inc. +25.66%

Vail Resorts, Inc. +23.68%

Hannon Armstrong Sustainable Infrastructure +15.20%

GAGEEIP:

Co-managed with Tom Konrad, Ph.D, CFA, the Green Alpha Global Enhanced Equity Income Portfolio is an actively managed Next Economy portfolio designed to produce a high level of current income. Comprised of global equities invested in Next Economy infrastructure and businesses with current yields in excess of the 10 year US Treasury bond. Income is further enhanced and risk reduced with the sale of covered call and cash covered put options. As with all Green Alpha strategies, entirely focused on sustainable economics and fossil-fuel free. GAGEEIP’s inception was in December 2013.

As a sub-advisor to Shelton Capital Management, the Shelton Green Alpha fun (NEXTX) embodies our sustainable economics’ philosophy with a somewhat more conservative risk/return profile than GANEX. With its introduction in 2013, NEXTX has allowed us to bring our thesis to the broad market via a low minimum investment ($1,000) as well as the opportunity for us to participate in the retirement plan marketplace. We continue to be proud and excited about the opportunities that the launch of NEXTX has brought to Green Alpha.

To obtain a prospectus, visit www.sheltoncap.com or call (800) 955-9988. A prospectus should be read carefully before investing. Shelton Funds are distributed by RFS Partners, a member of FINRA and affiliate of Shelton Capital Management. For performance and category ranking information, visit the NEXTX Morningstar page.

Green Alpha Developments in 2014

Assets Under Management Doubled in 2014:

We had a busy and productive 2014. Assets under management more than doubled for the firm, and we spoke at a number of industry events and conferences across the country sharing our Next Economy philosophy.

Green Alpha Hires Industry Leader, Betsy Moszeter, as Chief Operating Officerand continues to build team capabilities in the areas of investment research and business development:

We are very pleased to announce that Betsy Moszeter, industry leader, has joined Green Alpha Advisors as COO. Betsy comes with 16 years of investment experience, in both traditional asset management and sustainable, responsible, impact (SRI) investing. She was most recently the Senior Vice President and a Managing Member of First Affirmative Financial Network, LLC. Prior to First Affirmative, Betsy was the Chief Operating Officer and Chief Compliance Officer at TAMRO Capital Partners LLC in Alexandria, VA. Betsy’s responsibilities at Green Alpha include strengthening the firm’s infrastructure to expand capacity and increase efficiencies and internal controls. She can be reached by email at betsy@greenalphaadvisors.com.

Green Alpha also added Callie Weiant (callie@greenalphaadvisors.com) as Director of Business Development, where she works with institutional accounts, registered investment advisers, family offices and endowments. Jake Raden (jake@greenalphaadvisors.com) joined as Vice President of Research and Data Systems where his healthcare and big data expertise deepens the company’s research capabilities. Betsy, Callie, and Jake all add incredible talents and energy to our efforts and we are truly grateful they decided to join us. We’d also like to take this opportunity to thank Meredith Parfet, our Director of Marketing and Communications for her incredible contributions over this past year. It’s very rewarding and humbling for us to have so many talented individuals here at the firm.

After much hard work and dedication to Green Alpha, our friend and partner Robert Muir, decided that it truly was time to retire and has stepped down from his day-to-day duties at Green Alpha in order to spend more time with his family. Rob remains both a client and an owner in the firm and we are truly grateful for his service and continued support.

Growth of NEXTX Mutual Fund

Our partnership with Shelton Capital Management with respect to NEXTX has allowed the firm to democratize green investing to all investors. NEXTX is our only mutual fund offering and we are so pleased to be able to bring our sustainable economics thesis to the broad marketplace. In terms of risk/return profile, NEXTX is somewhat more conservative than our GANEX, SCGA and GASSP strategies. We have received excellent partnership support from Shelton Capital on NEXTX. NEXTX is now in quite a few 401(k) plans and is available on many major platforms including Charles Schwab, Fidelity, Pershing, TD Ameritrade, Merrill Edge and Foliofn Investments.

A big thank you to all: clients, partners, colleagues and everyone working to advance a truly sustainable economy. We couldn't have founded Green Alpha without you, and we wouldn't be here today without your support.

Important Disclosures: This information is for informational purposes only and should not be construed as legal, tax, investment or other advice. This information does not constitute an offer to sell or the solicitation of an offer to buy any security. Performance data quoted represent past performance, does not guarantee future results, and current performance may be lower or higher than the data quoted. Investment returns and principal will fluctuate with market and economic conditions and investors may have a gain or loss when you sell shares. Please refer to www.greenalphaadvisors.com for more information. “Green Alpha” and “Next Economy” are registered trademarks of Green Alpha Advisors, LLC. SIERRA CLUB, the Sierra Club logos and “Explore, enjoy and protect the plant.” are registered trademarks of the Sierra Club.

To obtain a prospectus for the Shelton Green Alpha Fund, visit www.sheltoncap.com or call (800) 955-9988. A prospectus should be read carefully before investing. Shelton Funds are distributed by RFS Partners, a member of FINRA and affiliate of Shelton Capital Management.

Solar photovoltaic (PV) as a means of deriving energy is fundamentally different from fossil fuel-based commodities (oil, coal, and gas). Consider: A solar PV panel can be thought of as nothing more than a hugely oversized computer chip -- a bunch of circuitry embedded in a silicon wafer. Indeed, in most economic sector classification schemes (GICS, etc.), PV manufacturers are defined as "semiconductors," which is basically true (if misleading in other ways). So different are the driving economics behind tech-based and commodities-based means of deriving energy, that we at Green Alpha are recommending to Standard & Poor's and MSCI that they consider formally separating the two into distinct subsectors.

Recently, though, the two types of energy -- oil and solar -- have been trading in tandem, both falling significantly since mid-2014. Traders by and large seem to be thinking "energy is energy." But this "energy-as-monolith" view is not appropriate to the reality of the economics, nor is it supported by the fundamentals.

To illustrate what I mean, a more valid comparison is that a solar PV company like First Solar, Inc. (ticker: FSLR) should trade more like a chipmaker, such as NVIDIA Corporation (ticker: NVDA) or Advanced Micro Devices, Inc. (ticker: AMD), than like West Texas Intermediate Oil. If we're going to treat similar investments as groups, then computer-processing power makes a better analog for solar modules than oil does.

In my sole exhibit here (above), it's difficult not to notice the similar and similarly dramatic price declines in solar PV in cost per watt (green line) and computing power in cost per GigaFLOP (blue line) over the last 37 years. Solar-PV–derived power has fallen some 170 times over that period. Computer processing power has declined in cost at many times even solar's rate, owing to huge demand and massive scaling. Meanwhile, Oil (red line) has done what commodities do: fluctuate in price according to demand and supply factors. Oil gets expensive when economies are growing, when there's geopolitical risk, when some nation or supra-national organization decides it wants it to be expensive, and so on.

Technology like computer chips and solar panels, in contrast, nearly always go down in price as demand goes up. Think about the price declines in computers and televisions over just the last five years -- and the simultaneous improvement in the products. But now the global economy can apply that same technology cost dynamic beyond goods to the energy that we use to power those goods and everything else.

Imagine what that means for world economies. When we grow and use more fossil-commodity–based energy, that energy becomes more expensive -- and economic growth is thwarted. But as we grow with technology-based energies, the increasing power demand decreases the cost of that energy and further stimulates economies! Put another way, consider the simulative effects as we realize the IEA's estimate of "over USD 115 trillion in fuel savings"[ii] by 2050 as the transition to tech-based renewables, chiefly solar, advances. Solar, although already grid-competitive in many areas, is just getting started. The blue line in the exhibit suggests what may yet be possible as solar technology evolves to enjoy the same level of scale and investment as semiconductors. Even with using current solar technology, though, $115 trillion is a heck of a liquidity injection.

Solar will become so inexpensive that it will inevitably continue to gain market share from fossil fuels, starting with those used to generate electricity (coal, then natural gas), and then, as the global economy adapts to make better use of renewable electricity in more sectors (think electric cars), it will displace oil. The popular current question "when will renewables reach grid parity?" will seem quaint and even funny in less than a decade. As one report has revealed, "a recent sign of the progress that solar is making in taking over the world: In 42 of the 50 biggest U.S. cities, home to about 21 million single-family homeowners, solar power is now cheaper than electricity from the power grid."[iii] This is happening because, again, as demand increases, so does scale, investment, R&D advances, and declines in installation expense, all of which lead to fast-falling overall costs. Solar PV module costs have declined "75 per cent since the end of 2009 and the cost of electricity from utility-scale solar PV falling 50 per cent since 2010."[iv] Now, reasonable estimates predict that "Solar Costs Will Fall Another 40% in 2 Years."[v]

Like a pundit in the 1960s or 70s predicting that the computers of 2015 would fill entire rooms and be capable of hundreds of calculations per minute, today's observers who believe solar is still an expensive, niche energy source will be proven badly mistaken.

Meanwhile, back in fossil fuel land, costs of production aren't getting any cheaper, even if barrel and pump prices (temporarily) have. Oil is expensive to find and to extract. That's why oil companies were cutting their exploration budgets long before the current oil price decline began in mid-2014. Unfortunately, a decline in oil prices does nothing to lower the costs of exploration and production -- meaning that oil's margins get squeezed.

No one has written more clearly on this than investor Jeremy Grantham: "As a sign of the immediacy of this problem, we have never spent more money developing new oil supplies than we did last year (nearly $700 billion) nor, despite U.S. fracking, found less -- replacing in the last 12 months only 4 1/2 months' worth of current production! Clearly, the writing is on the wall. It is now up to our leadership and to us as individuals to read it and act accordingly." In a sidebar, Grantham goes on: "The only longer-term price relief and net benefit to the economy will come when either we reverse recent history and start to find more oil more cheaply, which will be like waiting for pigs to fly, or when cheaper sources of energy displace oil."[vi] As economist Gregor MacDonald recently tweeted: "Sorry, did everyone forget Majors started cutting capex in Q1 of 2014, because $100 not enough to outrun declining ROI on runaway costs?"[vii]

In the end, no producer can sell oil for less than it costs to recover it. And those costs are high -- too high to compete in the long run. As Stanford lecturer Tony Seba recently said, "Put these numbers together and you find that solar has improved its cost basis by 5,355 times relative to oil since 1970...traditional sources of energy can't compete with this"v[iii] [italics added]. A nexus of effects is arising from the interplay of tech and commodity energy dynamics, and few if any of them are favorable to fossil fuels.

Solar PV is a technology, and its past and future cost dynamics will behave like those of a technology -- becoming ever cheaper. Oil is a finite commodity that is expensive to locate, extract, refine, and ship; it and other fossil fuels have had and will continue to have cost dynamics to match: economically volatile and forever affected by the cost of extraction.

Today, solar competes mainly with the other means of making electricity: coal, natural gas, and nuclear (more on how those stack up in my next post). In the long run, though, as our economy and infrastructure make more and better use of renewable electricity, oil and solar will compete directly in a way that they currently don't . By then, though, renewables, led by solar, will be so inexpensive that cost comparisons with oil will no longer spark argument.[ix] For now, suffice it to say that inexpensive oil can't and won't prevent the solar boom from continuing, because solar and oil, economically, scarcely share the same world.

Next economics posits that for the global economy and earth's tolerances/carrying capacities to run in a mutually tolerable equilibrium, we must continue to make rapid advances in economic efficiencies in all sectors. For 7.3 billion of us (and counting) to thrive on finite resources and avoid the worst effects of climate change, we have to drive more and more economic output from less and less input. Fortunately, energy is one of the areas where we can quickly make huge strides in this respect -- but not with fossil fuels in the mix. On the contrary, in fact. Efficiency gains across the global economy in the last few years have been such that, according to a Bloomberg piece titled "America is Shaking Off Its Addiction To Oil," "the U.S. is consuming less oil per dollar of gross domestic product in more than 40 years." In part, it is this slowdown in oil demand growth that's causing downward oil price volatility. The long and slow shift away from dependence on some fossil fuels, in other words, is finally starting to cause ripples.

Short Term Effects of Less Expensive Oil

Oil's recent narrative has become familiar: worldwide supply-and-demand economics (mostly declining demand, according to the World Economic Forum), expansion of both Libyan field and U.S. shale production, and as always, speculation. All well and good, but fundamentally what does it have to do with the prices of renewable energy stocks? At present, very little.

Investors are understandably concerned with solar, wind and other renewable energy stocks following the same pattern of oil trades in the market. The perception that all energy production is similar and can be treated and traded as a monolith, however, is a false one. As general awareness of the differences between types of energy advances, we expect this trend to slow, and then reverse itself. Solar, wind and other renewables will not follow the same trading patterns as oil, because more people will soon know better.

Many experts and other pundits have been weighing in to make this point. Lyndon Rive, CEO of SolarCity Corp. in a CNBC interview said, "the market doesn't understand the dynamics; this is a great opportunity to understand the issue and truly see if this is a big problem or not a problem and then capitalize on the opportunity. Oil has no effect or almost no effect on the cost of electricity in the U.S. In the U.S., almost no oil is used to create electricity, so even if oil went down to fifty [$50/barrel], it will have almost zero effect on the cost of electricity but the opposite is true too. If oil went up to a hundred and fifty [$150/barrel], it will have almost zero effect on the cost of electricity."

Rive's comments fit with Green Alpha's belief that investors are currently presented with a rare moment of market inefficiency, as broad markets struggle to clarify the role of a disruptive technology. In the near term, renewable energy investors should have little to fear from falling oil prices as there isn't much of an underlying reason why the two distinct assets classes should be valued in tandem. On the contrary, since the price of oil should not be affecting the price of renewables, one could use this moment of misunderstanding as an opportunity to initiate or add to a select solar and wind portfolio.

The first reason we believe this is that solar provides a competitive, economic advantage over diesel, coal or natural gas, because fossil-fuel prices, even if low at this moment, have proven to be quite volatile over time. A recent New Yorkerpiece on oil prices points out that "…oil has historically been more volatile than most other commodities; a 2007 study found that in the U.S. it was more volatile than ninety-five per cent of other products." The same can't be said of wind or sunlight -- once the capital expenditure for the systems to capture them and convert them to usable energy has been made, the price for fuel is zero. Indefinitely.

Again, Rive: "Fluctuations in oil prices have little impact on solar or many other renewable energy sources. This is partly why the economic proposition of solar is so compelling, unique and valuable…For example, up to 50% of the cost of a fossil plant is the expense of the fuel over the life of the plant, while sunlight is essentially free."

A recent energy cost analysis by investment firm Lazard validates the idea that oil pricing logically should be having a diminutive impact on renewables pricing, and goes on to calculate that the cost of energy from new utility-scale solar and wind power plants is increasingly competitive with more electricity-relevant comparative conventional fuels like coal, natural gas and nuclear, even without subsidies in some markets.

Image: Lazard, Levelized Cost of Energy Analysis -- Version 8.0, 2014

According to Lazard, the reason for this newfound economic advantage is that the long-term costs of utility-scale solar has fallen 20% just in the past year and 78% in the last five years. Declining almost as rapidly, wind energy costs are down 60% over the last five years.

With the application of Gordon Moore's famous law now visibly applicable to solar photovoltaic (PV) technology, and showing no signs of slowing anytime soon, it's plainly manifest that technology-based and commodities-based means of deriving energy do not belong to the same class of investable assets. Solar and oil, economically, scarcely share the same world.

In the Longer Run

The portfolio manager Jeremy Grantham has titled his latest quarterly letter (Q3 2014) "The Beginning of the End of the Fossil Fuel Revolution (From Golden Goose to Cooked Goose)." He writes, "As a sign of the immediacy of this problem, we have never spent more money developing new oil supplies than we did last year (nearly $700 billion) nor, despite U.S. fracking, found less -- replacing in the last 12 months only 4½ months' worth of current production! Clearly, the writing is on the wall. It is now up to our leadership and to us as individuals to read it and act accordingly." Grantham refers to U.S. fracking as "the Largest Red Herring in the History of Oil," noting that its economic advantages may be short-lived.

The International Energy Agency (IEA) has recently written that "The sun could be the world's largest source of electricity by 2050." Mostly, it says, because of declining costs, and not so much because it can help battle climate change, although that could be a growth factor as well.

The key point in this analysis is that solar is a technology, and it's past and future cost dynamics will look like technology -- becoming ever cheaper. Fossil fuels are commodities -- finite and expensive to locate, extract, refine and ship -- and fossil fuels have had and will have cost dynamics to match: very volatile. In the long run, 10-20 years from now, as our economy and infrastructure can make more and better use of renewables, the two will compete directly in a way that they do not now, but by then renewables, led by solar, will be so inexpensive that the cost comparison will no longer spark argument but will seem quaint. So different are the commodity and technology means of deriving energy that we at Green Alpha have proposed that they be classified as different sectors altogether.

Ultimately, as the next economy advances and we increasingly transition to using renewables (electricity) to power things that currently rely primarily on liquid BTU (such as transportation and some heating) solar and oil will indeed compete with each other directly. When that time comes, oil will again become cheap, because demand for it will have fallen dramatically as renewables, ever cheaper, command more and more market share. Even then, though, oil won't be economically competitive, because no matter how inexpensive any "cheap" fossil fuel becomes, it will always be more expensive than the free fuels employed by wind and solar. And any power plant converting fossils to electricity will also have far higher operating costs than do most renewables.

As Bloomberg's Michael Liebreich recently said, "The story should not be how falling oil prices will impact the shift to clean energy, it should be how the shift to clean energy is impacting the oil price."

Ultimately, the next economy can only thrive on power that is nearly free, inexhaustible, that does not contribute to systemic risks such as climate change and a toxic atmosphere, and that can be sourced nearly anywhere with a relative minimum of effort. Only solar PV, and to a slightly lesser extent wind, can reach this extraordinary level of economic efficiency. The writing is indeed on the wall, and the days of high market correlation between tech power and fossil power will soon be behind us.

To attempt an investment strategy that legitimately excludes securities of fossil fuel companies, it's necessary to reevaluate traditional investment management practices, and then to innovate ways in which that profession can evolve to mirror the rapidly changing times in which we live. At Green Alpha, we call this approach "Next Economy portfolio theory," and we practice it continually in our workaday job of portfolio construction.

But before I get to some of the details of our method, let me be very clear about one of its key conclusions: If you own fossil fuels, you own global warming. You own the most likely cause of economic and even civilization-level failure and, moreover, you own a power source that is having an increasingly tough time competing economically. This is the opposite of what any fiduciary -- with responsibility for the safety of their member and client assets over the long-term -- should be doing. Our use of fossil fuels is causing untold degradation to our required systems. Greenhouse gas emissions, release of myriad other toxin,s from mercury to methane, destructive extraction practices, freshwater contamination, and so on. We all know the list, and we should all know that as a result, the continued use of fossil fuels and an indefinitely thriving human economy can't coexist for much longer. Thus, fossil fuels–free investing can be defined as an economic premise as easily as a moral argument.

And the economics of a long-term functioning global economy are the core of our theory. The Next Economy is one that will allow humankind to maintain and improve our standards of living while simultaneously reducing our planetary impact. The successful shift to the Next Economy rests on the following solutions: Power ourselves entirely with renewable energy, develop a closed loop system where all materials can be recycled with zero waste (waste-to-value), innovate increasing efficiencies to the point that our global economic activities have a negligible footprint on the earth's ecology, and shift our default setting from short term resource exploitation to long-term resource management.

Using science-driven, fundamentals based research, we must invest in companies whose innovative products and services address an increasingly warmer, more populous and resource constrained planet. At heart, Next Economy approaches to investment management are deceptively simple: don't invest in the things that have the power to disrupt the economy, our ecology and even our civilization, and do invest in the solutions to those things.

This involves an evolution of traditional investment management. Where conventional portfolios are constructed starting with a list of companies, then screening out firms for various economic, fundamental, and/or social criteria, we start by asking "what are the global economy's key risks and issues and what can be done about them?" So rather than beginning with a list of companies, we end with a set of companies. Companies we believe represent the future, indefinitely sustainable economy. We do this because we believe that what the global economy needs now are new policies and institutions that accommodate uncertainty and anticipate nonlinear change, both of which are realities of the Anthropocene. This includes -- and probably should be led by -- investment management.

Figure: mapping the Next Economy onto the present economy

Human civilization is far too complex and has far too many variables for us to be able to predict the future. But we can imagine what may be. And, in light of our belief that rapidly increasing rates of innovation mean that the near future will be very different from the past, we think our most considered projections of the shape of the fast emerging Next Economy are our most likely source of competitive returns, and also a global economy that begins to provide for all people while simultaneously pulling us back from the brink of overtopping Earth's carrying capacities. My job is to learn from scientific findings to improve risk mitigation in the context of portfolio management. We can (and do) debate which solutions work best or can be scaled most rapidly, but not whether there is a problem, or whether investment at a massive scale is required to address it. Those cases are closed.

We believe that no portfolio should contain the causes of risks that threaten our economy, ecology, and even our civilization. We believe that investing in the solutions to those risks is the clearest path to a sustainable economy and also to potentially competitive returns. As a result, Green Alpha Advisors has never purchased any security of a fossil fuels company since our founding in 2007, long before "Divest" or "Fossil Free" were widespread concepts. We believe the power of human innovation is proving itself to be far greater than the declining power of fossil fuels.

Disclosure: Investors should carefully consider the investment objectives, risks, charges and expenses of the portfolios and/or Fund before investing. There are risks involved with investing including the possible loss of principal. Past performance does not guarantee future results.

As I've written before, "human economies are still so far from real sustainability that even a highly idealized portfolio of our most sustainable enterprises necessarily falls short. Ultimately, the best any portfolio can do is mirror the reality of the world, and today, still, even the best representatives of sustainability can be found wanting compared to what will be required if we would like to keep society thriving indefinitely."

There's no better example of the various conundrums swirling around sustainable economics than GMOs. As one institutional client, Timothy Yee of Green Retirement Plans, recently emailed to me, an "Issue that I am having is with Hain Celestial (ticker: HAIN) and its stand on GMO not labeling/mislabeling. Given this issue, I am in a bit of a quandary. What are your thoughts on the GMO front?"

This is a complex one, and it points out that there really are "50 shades of green," especially in portfolio management, and that no shade is perfect -- far from it.

And yet, we think that our follow-the-science, empirical, evidence-based methodology keeps us as close to a pure realization of a sustainable-economy model as you can find, given the world as it is today, and particularly given the state and entrenchment of the investment management field today, where most clients and advisors remain stubbornly invested in the primary causes, fossil fuels in particular, of the key systemic risks with the power to cause turmoil in economies and societies.

So, where do we believe the empirical approach to observing the world leads with respect to GMOs? First, we know there are questions about where the science will lead us, but we don't believe that GMOs are universally bad. We do not, as a firm, screen GMOs out, per se, although we do not currently own any GMO inventors or development labs, and our Sierra Club Green Alpha portfolio (SCGA) does screen out GMOs explicitly. We do believe that, as with any technology (AI comes to mind), misuses can be and are deleterious. For example, we object strongly to GMOs such as "Round-Up Resistant Corn," which has been gene hacked to tolerate a huge quantity of toxins that then in turn of course end up in everything -- our food, water, oceans, and bodies. This type of application is not the path to indefinite sustainability and has to stop. Our portfolio construction theory of avoiding systemic risks and investing in solutions to those threats would never allow us to invest in GMOs of this type.

And yet, there are advantageous gene hacks that do give us a shot at mitigating some large systemic risks. Higher-yielding crops can alleviate hunger, drought-resistant crops can conserve water and keep agriculture going in the many places in the world that are drying out (California seems to be emerging as ground zero recently), and in other cases, plants have been modified to improve nutritional content. On the point of drought-resistant crops, Stanford's Dr. Henry I. Miller has posted a particularly informative piece on GMOs and public policy in which he concludes, "As water scarcity increases, drought-stricken crops wither, and food prices rise, the need for resilient agriculture will become more obvious -- and more urgent. With more rational public policy, we can meet that need now. How much more preventable misery and death must occur before our policymakers see reason?"

Indiscriminate rejection of GMOs, in my opinion, only serves to obscure variation among applications. Therefore, as a position, it lacks depth.

We don't think Hain Celestial (HAIN) is likely to be distributing many of the worst kinds of GMOs, since its focus on organics means it's not getting a lot of raw materials (and resulting SKUs) from pesticide-using farms that might use pesticide-resistant seeds. That said, we do of course believe folks deserve to know what they consume, so transparent labeling -- whatever you think of GMOs -- should be required, and this is the kind of thing where we'd consider some shareholder activism to nudge HAIN to reconsider on this front. Activism, but (as long as we like the fundamentals!) not divestment. HAIN is the most diversified natural and organic product producer, and offers a ton of sustainable alternatives in food and personal care in numerous channels. Therefore, to us it represents a strong next-economy analogue to a legacy-economy rival such as, say, Unilever (ticker: UN).

Finally, in a larger sense, we can't help but agree with astrophysicist Neil Tyson's take on the issue: that "We have systematically genetically modified all the foods, the vegetables and animals that we have eaten ever since we cultivated them. It's called 'artificial selection.' That's how we genetically modify them." Tyson's no-hysteria approach gives us some context, and further, as Ezra Klein points out in the same article, one key cultural difference in addressing ideas that are at odds with the underlying science in conservative and progressive circles "is that conservatism's mistrust of climate science has taken over the Republican Party -- even politicians like Mitt Romney and John McCain have gone wobbly on climate science -- while liberalism's allergy to messing with nature hasn't had much effect on the Democratic Party. And part of the reason is that the validators liberals look to on scientifically contested issues have refused to tell them what they want to hear." On warming, validators like Ann Coulter will tell her base what they want to hear all day long. On GMOs, Tyson, as befits a scientist, defaults to the evidence and tells it like it is.

Disambiguation of the many and varying underlying issues is what this -- and many other issues within sustainability -- is really about. As Tyson later explained on Facebook:

"If your objection to GMOs is the morality of selling nonprerennial [sic] seed stocks, then focus on that. If your objection to GMOs is the monopolistic conduct of agribusiness, then focus on that. But to paint the entire concept of GMO with these particular issues is to blind yourself to the underlying truth of what humans have been doing—and will continue to do—to nature so that it best serves our survival. That's what all organisms do when they can, or would do, if they could. Those that didn't, have gone extinct."

Recognizing blind spots that can lead to misinformation and, in the case of our field of investment management, therefore to inefficient markets, is a big part of what I try to do.

Is there today such a thing as an indefinitely sustainable economy? No. But we can see a way there, and that way is paved with innovations and increasing efficiencies, and we don't think we can afford to avoid the most promising representatives. Folks like antivaccinators and blanket GMO opponents ignore scientific consensus to their (and our!) peril.

Disclosure: Green Alpha Advisors is long HAIN, and holds no positions in UN.

[Note: this is part of Green Alpha's ongoing "50 Shades of Green" series, wherein we endeavor to disambiguate the sustainable and less sustainable aspects of sectors, industries, trends and companies. – GJ]

[In this post, Green Alpha Senior Vice President Robert Muir discusses the opportunities and risks of investing in renewable energy yieldco's. - GJ]

Given the vigorous investor quest for yield as the Federal Reserve maintains the benchmark Federal Funds rate near zero, and the resurgence of attention being paid to renewable energy generation, mainly solar, and to a lesser extent wind and hydro, it's no wonder Yield Co's have gained so much investor interest lately. In the near to mid-term, the enthusiasm may be justified. Supported by Power Purchase Agreements, energy infrastructure financing and leasing contracts, and electricity transmission and distribution concessions, all with credit-worthy counter-parties, Yield Co's are designed specifically to pay out a large portion of their EBITDA to shareholders in the form of dividends. By virtue of their steady cash flow and above-market yields, these companies tend to be viewed by investors as relatively safe and stable, similar to high-yielding traditional utilities, and their shares tend to trade with low volatility and beta.

Structured as they are to generate and pay out cash flow to investors, these firms are to a large extent valued on both current yields and their anticipated ability to maintain and increase future dividends. Therefore vigorous deal flow and a robust acquisition pipeline are key. I'm most in favor of Yield Co's that are direct spin offs and by contract have Right of First Offer (ROFO) on any projects developed by the parent. The other very important factor I consider is financing. I like to see structured debt financing at attractive rates that is properly engineered into the financial metrics of the acquisition. I tend to avoid Yield Co's that finance development projects and acquisitions with the issuance of new equity.

Green Alpha advisors does hold Yield Co's in some of our portfolios. One I particularly like is Pattern Energy Group (PEGI). PEGI has the ability to expand its MW production capacity, and therefore grow its revenues and cash available for distribution (which is even more key), through a solid pipeline for identified projects from Pattern Development on which it has ROFO, while also being able to consider beneficial third party project acquisitions. It will benefit through 2016 from the Federal Renewable Electricity Production Tax Credit. PEGI currently holds only wind-capacity generation in its portfolio, but management is open to adding solar as well. The company has a stated goal of increasing its cash available for distribution by 10-12% annually and increasing its dividend by 12% annually over next three years.

With a current yield of 4.10%, and an annual dividend of $1.31, PEGI is currently fairly priced at around $32.00. Its forward performance estimates are trending nicely, with estimated full year revenue growth of 25.5% in 2014 and 35% in 2015 and estimated full year EPS growth of 32.8% in 2014 and a whopping 133% for 2015. Both its Price to Book and Price to Cash Flow are estimated to trend lower in 2014 and 2015. Its EV/EBITDA valuation ratio is high, but not relative to its superior EBITDA, and its EV/EBITDA vs. EBITDA ratio is markedly more attractive than many of its competitors in the same space. PEGI seeks to pay out 80% of EBITDA, and if the company performs as estimated it should be able to meet both that benchmark and its dividend growth targets. If the company does meet those growth targets its annual dividend in 2017 will be $1.67. All things being equal, if the yield were to remain at 4.1% that would potentially make for a 2017 price of $40 a share. Inversely, if the price were to stay close to $32.00, the 2017 yield will have ballooned to 5.2%.

While acknowledging many positives, I do see some risk in owning shares in these firms. Firstly, Yield Co's stock valuations, like traditional dividend paying utilities, or any high yield investment instrument for that matter, are often considered bond proxies, and have negative exposure to a rising interest-rate environment. A seven, six, or even five percent yield might seem extremely attractive when the Ten Year U.S. Treasury Note is yielding just 2.52%, but if or when benchmark interest rates return to more historical norms, income investors may not be willing to pay today's prices for shares with those same yields. To offer some context, in 1995 the Fed Funds rate was 5.5%. In the minutes from the most recent Federal Reserve meeting, released on July 9, FOMC members anticipated the fund rate will be at 1% in 2015, 2.5% in 2016, and 3.75% in the longer term. To preserve share prices in a rising interest rate environment, Yield Co's will need to be able to increase their dividends commensurately.

Also, as the number of publicly listed alternative energy Yield Co's has risen, the demand from these firms to secure alternative electricity generation projects has also spiked, leading to less attractive pricing and revenue metrics on third-party, competitive-bid acquisitions.

Another potential risk that Yield Co's face, albeit in the longer term, is the threat to the traditional "Hub and Spoke" electricity generation and distribution model. This is far and away the preferred model of the majority of the holdings in Yield Co portfolios. As the generation and storage technologies that will bring about distributed and eventually autonomous energy production advance, this utility model will become increasingly less economically viable. I know of only one Yield Co at this time, NRG Yield Inc. (NYLD), that has two commercial, distributed-solar facilities in its current portfolio of holdings, and these are just a small portion of the company's total portfolio. This is clearly a longer-term concern and doesn't affect my near-term analysis of the space or of any individual companies. However, it is something I will continue to monitor.

In my view, Yield Co's clearly have a role to play in any diversified equity investment model, particularly one designed to generate dividend income.

Disclosure and Sources:

Green Alpha Advisors is long PEGI and has no position in NYLD. Data on PEGI is sourced from Thomson Reuters as of 08/05/2014. This information is for information purposes only and should not be construed as legal, tax, investment or other advice. This information does not constitute an offer to sell or the solicitation of any offer to buy any security. Some of the information contained herein constitutes "forward-looking information" which is based on numerous assumptions and is speculative in nature and may vary significantly from actual results. Green Alpha is a registered trademark of Green Alpha Advisors, LLC.

About three weeks ago, I posted a piece called "RGS Energy, Tempered, Opportunistic Growth," an optimistic bit of coverage on one of our holdings, (RGSE), that included an 18-month price target of $10.00 per share. Since then, several developments and pieces of information have come to light that have caused us to revise our assessment of the company.

Thursday, July 3, a quiet half-market day, RGS Energy released a statement announcing plans to monetize its previously filed potential shelf offering; "RGS Energy (NASDAQ: RGSE) has entered into a definitive agreement to raise approximately $7.0 million in a private placement financing transaction. Under the terms of the agreement, RGS Energy will issue units consisting of an aggregate of 2,919,351 shares of its Class A common stock and warrants to purchase up to 1,313,708 additional shares of Class A common stock, at a price of $2.40 per unit." This deal has been offered to and accepted by as yet undisclosed buyers at well below RGSE's market price in the $2.90s on July 3. The market reacted unfavorably to this low self-valuation from RGSE, driving the share price down approximately 16 ½ percent in the two market days that have followed the announcement, but even so, the private placement valuation remains below market as of this writing.

It gets more interesting. Not only do participants receive this fire-sale valuation, but also, "[e]ach unit consists of one share of Class A common stock and a warrant to purchase 0.45 shares of Class A common stock at an exercise price of $3.19 per share. The warrants are exercisable beginning six months after issuance and for a period of five years thereafter." So participants are buying already in-the-money shares, and also getting up to 5 ½ more years to watch the company grow, risk free, before deciding whether to buy more shares at $3.19. Frankly, I'm surprised that management thinks little enough of their firm that they felt the need to offer such a cheap price and also such a fantastic sweetener to raise equity capital. Not knowing all the deal details, I may be missing something, but if this was the best valuation RGSE could get for equity, why didn't they use low-interest debt instead? As of last report, the company had zero long-term debt, a perfect position for a cash-flow positive business to fund operations on the cheap with some kind of note offering.

All in then, up to 6,137,936 dilutive RGSE shares may be sold at $2.40 and $3.19 per share, representing up to 13.65 percent dilution to the existing shareholders of the previously outstanding 44.97 million shares. This is in exchange for $6.4 million (net: of the $7mm raise, close to 8.6 percent, or $600,000, is going to fees and expenses) in "operating capital," and "debt repayment," and not necessarily so much for expansion, except a vague statement about proceeds "to support the launch of its residential leasing platform."

When we met with RGSE's CEO Kam Mofid on May 22, 2014, we asked him about the shelf filing that made this transaction a possibility. That day, he told us that a "shelf offering is filed, but it is to be used only opportunistically for tactical expansion." We understand that business needs can change -- even in just a six-week period -- but the terms of the execution of the shelf offering and the uses of capital as represented in the press release don't seem to agree with Mofid's in-person confidence in opportunistic growth via smart use of his war chest. And Mofid represented to us that RGSE has no debt except for a revolving credit line with Silicon Valley Bank (SVB), which in late May he told us they pay off in full every quarter. So in what sense can their press release be accurate about using proceeds to pay down debt? Only in the sense that they will pay off the SVB line -- something they were already doing with cash flow -- with the new capital. On the contrary, now would have been the time to take on debt rather than issue new equity, thus providing the opportunity to grow the firm to the point where they could get a much better valuation for its shares upon exercising the shelf offing in another year or two.

In the end, we can't help but feel that RGSE's newly announced sources and uses of capital conflict with the business approach as articulated to us by the firm's CEO less than two months before.

In the last post, I wrote that RGSE had every chance of hitting $10 per share by the end of 2015. That was based partially on the rapid growth of the solar installation industry, on our confidence in management ability to execute, and also partly on my assessment of RGSE's value relative to the total market capitalization of SolarCity (SCTY). Since that post, SCTY has announced plans for massive vertical integration of PV panel manufacturing of the most technologically advanced panels and at prices competitive with any panels out there. This has changed the fundamental nature of SCTY and renders moot my comparison of two installation-only firms.

Where SCTY has added a high-tech manufacturing firm to its business, RGSE has signed a supply agreement with SolarWorld to source panels for installation. We can't help but notice that it was SolarWorld that persuaded the Commerce Department to levy tariffs on Chinese solar panels imported into the U.S., thus doing more to slow the growth of RGSE's core business than has any other single entity. According to Forbes, SolarWorld has been called "a crazed agent provocateur" and "[a]t a recent dinner in San Francisco, Suntech chief technology officer Stuart Wenham, an Australian, was just as blunt. 'SolarWorld is a pariah…No one wants to deal with them.'" SolarWorld's continuing efforts to undermine the economic competitiveness of solar PV in the United States would seem to fly in the face of RGSE's long-term business interests.

Finally, then, we have to revise our price target. To external appearances, it seems RGSE may not be acting entirely within the best interests of the firm or its existing shareholders. Eschewing presumably cheap debt in favor of expensive, dilutive equity fundraising, and offering a sweetheart deal to get it done, seems to show an internal lack of confidence in the firm's valuation and near-term prospects. Nevertheless, the simple fact that RGSE finds itself in one of America's fastest-growing industries still bodes well for growth, and with the low current valuation, for the possibility of a takeover. We're lowering RGSE from "buy" to a "hold" rating, and lowering our 2015 price target to U.S. $5.00. While we're disappointed with current events, and we don't presently intend to accumulate more shares, we are not planning to immediately exit our position in RGSE, since, as our price target indicates, we do think there's upside potential from the current $2.53.

Kam Mofid has a more long-term vision than most CEOs. His emphasis on the next earnings per share (EPS) report and his obsession with short-term focus are minimal relative to America's typical boss. He's not primarily managing to the next quarter.

His company, RGS Energy (ticker symbol: RGSE), is a solar-module installer, mainly in the residential vertical. RGSE doesn't directly compete with most solar panel manufacturers. Instead, it provides residential rooftop installation distribution for them. It then captures lease payments and revenues from selling excess electrical generation to the grid (in states that allow it). Whereas First Solar (FSLR), Canadian Solar (CSIQ), and Sun Edison (SUNE) are primarily engaged in module manufacturing and commercial and utility-scale installations (although not exclusively -- this is a fast-evolving area), RGS Energy and its larger competitor SolarCity (SCTY) are all about home/residential installations. For now, only three residential installation players have national reach: SCTY, RGSE, and Vivint, Inc. (Vivint is privately held and not discussed here).

RGS Energy was once the idealistic brainchild of green-oriented consumer -goods firm Gaiam, Inc. (GAIA), and was then known as Real Goods Solar. Mofid joined in 2012, soon after RGSE was spun off from its parent, and quickly moved to modify the makeup of the board, diversify the shareholder base, and "move away from the hippie business mentality," bringing on a number of individuals with practical experience and track records of delivering successful businesses.

Pragmatically, RGS Energy didn't become a true competitor to SolarCity until Mofid joined the company. Not that Kam Mofid and his team are necessarily trying to catch SolarCity in terms of scale or market share. They believe their industry's growth potential will generate enough market share to go around. In Mofid's words, "there's plenty of work to do." Since residential installations don't require any new land development, rooftops are effectively brownfields, and as such represent a great low-impact source of electricity. And Mofid sees many greenfield opportunities in those brownfields.

Whether via smart strategy or just good timing, Mofid and his team have had benefitted from observing SCTY's successes and encounters with pitfalls. SCTY in many ways has paved the way in the residential installation business, and RGSE has had a bird's eye view of the process -- stumbles and all.

As a result, RGSE has chosen not to directly emulate SCTY. In Mofid's opinion, that company is taking on inappropriately high risk. In particular, Mofid thinks SolarCity is banking too heavily on its retained-value-model and being too aggressive in terms of assumed value of solar modules after 20 years of depreciation and continuing technological innovation. Learning from SCTY's success and risks with this model, RGSE will soon no longer rely on tax-equity concepts, reflecting a belief that retained value made sense in the past but no longer applies in "2014 thinking." Already, RGSE has incorporated lower tax value into its growth model as a risk control.

Mofid is not as sanguine as SCTY is about the retained-value-model of valuing solar panels. He also believes that SolarCity is in general too aggressive and too eager for risk -- not only in poor potential realization of retained value of installations but also, and perhaps more importantly, in the "deteriorating policy and subsidy environment in the U.S.," and on a state by state basis.

In any fast-growing industry where the name of the game is to capture as much emerging territory as possible, it's always a struggle to manage between top line growth vs. EPS. Here, RGSE, like SCTY, has chosen to invest in growth at the expense of current EPS, but in a more conservative way than SCTY. As Mofid says, "meaningful GAAP revenue is possible soon with our model."

There is not yet a clear winner between the more and the less aggressive strategies, not that there needs to be. That two of the three largest solar installer companies in the U.S., SCTY and (the much smaller) RGSE, each employ one of these approaches means that a public equity investor can get exposure to both and not have to choose between methods. This is fortunate, because it's possible that both the rapid and the measured growth strategies could turn out to be winners. We like both the high-growth SCTY and the measured-growth RGSE, as each brings interesting and potentially valuable characteristics. Another benefit of investing in both approaches: Not only do RGSE and SCTY employ different approaches to managing growth but they also don't operate in many of the same states. However, for investors who find SCTY's all-out-for-growth approach too aggressive, RGSE may represent a more temperate alternative.

The residential installation market is new and growing fast, so larger players with more access to capital have a major advantage over smaller, locally based firms, both in ability to leverage pricing, engage more projects, and have the flexibility to emphasize growth in states with the most favorable conditions for the solar installation business. This last point is more important than it may seem: Many areas, under the sway of the local public utility commission and the monopoly or near-monopoly of electric utilities, can, or have, or may at some point attempt to stall growth in solar with policies unfavorable to the industry. A national model diversifies and mitigates this risk. Ultimately, as renewable energies cause overall electricity prices to fall, sentiment will cause states and utilities to relent, which will ultimately help solar and wind all along their value chains, but until then, geographic diversity is going to be key. RGSE currently operates in 16 states.

Mofid has a goal of becoming and remaining at least the third-largest installer nationally. His understanding of the scope and depth of the solar installation market in the U.S. shows strongly here: He is content to capture 1/10th of that rapidly growing business.

So RGSE is now beginning to take steps to accelerate growth. Primarily, this is taking the form of a financing joint venture called RGS Energy Asset Management, owned with Altus Power America Management. Goldman Sachs (GS) has agreed to provide capital access for the JV, but Mofid didn't address the terms or scale of its involvement. (Goldman evidently likes installation diversification as much as we do: They are also major capital providers to SCTY.)

RGSE has a couple of other sources of and access to capital. First, the firm currently has no long-term debt, only a revolving line of credit with Silicon Valley Bank that it pays down to zero at the end of each quarter. Long-term debt financing does appear to be in the cards going forward, though. As Mofid says, with respect to expansion, "there will be a debt aspect". Second, they have a $200 million mixed shelf filing reserved to fire growth (acquisitions and capital) when they perceive an opportunity.

Near-term, Mofid feels the industry has now and will continue to have access to state and federal incentives at least until 2016. After that, incentives most likely won't go away, but may drop by some meaningful percentage. So Mofid projects the solar installation industry will have record growth through 2016, then slow a bit, which concurs with our own view of the situation.

When asked what RGSE's key risks involve, Mofid gets more macro. Utilities present a patchwork, he says: "some good, some quite bad" (he says RGSE's home state of Colorado, for example, is currently a tough environment), so, again, a national model is key to offset that risk. As a result, the residential installation industry will likely experience both consolidation and failures of local installer firms, providing growth-by-acquisition opportunities for all three major, multistate players.

Regarding tariff risk involved with buying modules from Chinese manufacturers, Mofid sees the additional costs as "very low" relative to his business at $0.02 to $0.05 per watt (I note here that this actually presents meaningful inflation for utility scale plant developers that depend on Chinese prices, but that's a different discussion). Moreover, RGSE buys from multiple panel manufacturers, and most of these are positioning themselves to make and ship from plants outside of China (via possible additional manufacturing capacity in Mexico, for instance).

Manageable as Mofid sees them for now, there are definite political risks involved with being a solar installation business in the U.S., including states' regulations, utilities' intransigence, and national tariffs. Investors should consider their view of national and local policymaker sentiment toward renewables when assessing risks associated with an investment.

And perhaps those risks explain RGSE's recent lackluster share performance and high short interest of late. On the latter, RGSE has recently hired a professional short interest monitoring service to report violations of shorting rules (such as naked short selling) to FINRA. This may have the effect of dissuading unscrupulous shorters, but I doubt it. I'd rather see RGSE spend capital growing, and silence the critics that way.

There's also been bad press regarding RGSE's recent Hawaiian acquisition, Sunetric. And not without reason -- Hawaii presents other risks and opportunities. The business pipeline there is mostly comprised of commercial demand, so residential firms may face declining business and ultimately attrition, potentially including RGSE. But this may also mean larger firms with geographic diversity away from the islands and some staying power may be able to consolidate market share. It's too soon to tell.

That said, the Hawaii deal reveals some RGSE strengths. Mofid and team were willing and able to move nimbly from a cash/equity deal to an all-equity deal as the situation with Sunetric evolved. The Sunetric acquisition is interesting for another reason. Mofid says RGSE is, again, like SCTY, becoming active in the solar-to-storage space, and he thinks they can use isolated, contained-grid environment and expensive-utility bill center Hawaii as an ideal proving ground for perfecting a business model that can work. And the two residential installation firms aren't the only ones who think the panel-to-storage model will work. As Barron's recently reported, "Barclays this week downgrades the entire electric sector of the U.S. high-grade corporate bond market to underweight, saying it sees long-term challenges to electric utilities from solar energy… and recommends investors who can do so should underweight the electric sector versus the broader U.S. Corporate index, and rotate out of bonds issued by utilities in areas 'where solar + storage is closer to competitiveness.'" RGSE is looking at both Hawaii and California markets for the solar+storage model, and they will look to "innovate into those services as technology comes on line."

SCTY has a major advantage over RGSE in the storage race due to its sisterhood with Tesla Motors (TSLA) and its forthcoming Gigafactories, which may produce high-quality batteries for as little as 60 percent of the cost of other manufacturers. But this doesn't mean RGSE can't make significant progress with the same model, especially in states where SCTY is not present.

Similarly, RGSE plans to keep expanding within its existing markets. Where there is no strong local player, RGSE can establish its brand and presence de novo; where there is a local brand that is already valued by the community, there could be opportunities to acquire installers with their infrastructure, employees, trucks, and sales pipelines. Mofid mentioned twice that the residential solar installation space is still in its "constantly evolving," "Wild West" stage, and that keeping a war chest (no debt yet, shelf filing) ready for his "best opportunities" is his approach. It's hard to disagree with this, and yet we can't help but wonder whether he shouldn't be deploying his war chest a little faster; sometimes the largest risk is the one you don't take, and residential solar installation won't be an immature market forever.

When we asked whether sitting on the "war chest" of unused shelf offering and zero debt is itself a risk, Mofid sidestepped. While he did affirm their forward guidance, he gave little insight on a concrete path toward achieving this guidance, offering only, "we're gonna keep doing what we're doing." What we can glean from regulatory filings and conference call transcripts reveals only a bit more clarity. Important components for RGSE's roadmap include establishing new funding vehicles for project financing (that may or may not be part of the current JV), which must be an essential aspect of the plan to move away from relying on tax equity in financing and bankrolling ongoing business operations.

Mofid clearly passionately feels that the industry is compressing, and small installers will be pushed out, leaving space for companies like RGSE to move in with their larger bankrolls and resources to capitalize on the vacuum. For now, RGSE is estimating 50-55MW installed capacity in 2014, but it's not clear if this includes the acquisition of smaller private solar firms.

In any event, "what we're doing," for now, also seems to include expanding installation capacity via acquisitions. The last four of the company's buys were paid for primarily with RGSE shares; so far, Mofid seems to be taking a bet on dilution over debt. And it appears that RGSE is about as petal-to-the-metal as it can realistically be at this point: Mofid noted that the company's final acquisition in 2013 slowed its plans down significantly as it dragged on through the first quarter of 2014. It seems that RGSE has capacity to take deals one at a time, but not faster. And evidently, this suits their temperate growth model fine.

We asked Mofid if the confluence of new efforts to grow, emphasizing states where SCTY is not already present, and having not yet taken on any debt means RGSE is beginning to position itself as a possible acquisition target. Mofid says they have no current focus on becoming part of a larger peer such as SCTY or any other potential bidder. Further, since Mofid claims "there will be a debt aspect to our growth plan," it seems the zero debt balance sheet will at some point give way to the desire to expand. Still, while not currently courting suitors, Mofid admits that "everything is for sale."

Between now and 2016, both SCTY and RGSE are likely to accumulate small local installers within a chaotic environment of consolidation, regulatory changes and price fluctuations. It may well be that some panel manufacturers and utility-scale players such as SunEdison (SUNE) and SunPower (SPWR) are waiting for the residential space to sort itself out before deciding to make offers for firms like RGSE, which could then act as verticals to get their panels into the U.S. residential market.

Acquisition target or not, we see no reason why RGSE should not realize market capitalization growth to about eight to 10 percent of that of SCTY. As of the time of this writing, that implies a 300 to 400 percent upside for the stock, not counting 2015/2016 growth. Thus, we feel comfortable placing a $10.00 2015 price target on RGSE. And considering the rapid growth of the industry, higher valuations than that going forward from there are Mofid's to lose.

Background notes on Kam Mofid:

Canadian-born, from the Niagara Falls area

Undergraduate degree from University of Waterloo

Was a fellow at GM Canada, sent to

Georgia Tech for his masters

Strong engineering and primarily automotive background

29 year old exec at UTC

First non-founding president at REC Solar

In 2011, brought over to MEMC (SUNE), just in time for the solar market crash

In July 2012, RGSE called Kam with CEO opportunity

RGSE at that time was controlled by GIAM, and had very low trading volume. Mofid turned over the board and diversified the shareholder base, now 17% owned by a Boston PE firm via several rounds of share issuance

He hasn't sold a single share of his holdings yet

Has little professed regard for analyst/commentators who write negative things about companies he leads -- he feels most focus too much on short-term results at the expense of long-term shareholder benefits

RGSE Suppliers:

Panels: CSIQ, STP, and several others. RGSE does not utilize long-term purchase requirements

Disclosure: Green Alpha® Advisors has current positions in RGSE, SCTY, SPWR, FSLR, CSIQ, SUNE, and TSLA. Green Alpha has no holdings in or near-term intention to buy any other company mentioned in this post.

It's unavoidable that our Green Alpha portfolios get caught up in short-term market volatility, such as a general downdraft for perceived "growth" equities like the one we've experienced in April and May this year. But we believe that by carefully selecting growth and value stocks with great fundamentals, we are building portfolios that stand every chance of being early to recover, and on that basis we consider these inevitable periods of market consolidation attractive entry points within our methodological approach.

This April, and thus far in May, geopolitical events and perceived slowing in China's economic growth (among other things) have caused a general shift away from growth stocks to more traditional value stocks. Anything thought of as high momentum or high growth has been sold in favor of more traditional blue chips -- here I cite that the DJIA 30 was the best performing broad index in April. Of course, the possibility exists that this trend may continue for a while, but the possibility equally exists that the shift may have run its course and that now traders will begin to hunt for bargains among the growth stocks that have pulled back. Either way, the point is that stocks with good fundamentals (and working in rapidly growing areas -- like the solutions to society's most pressing systemic threats) are not declining due to company-integral issues, but rather are being caught in generalized negative market sentiment.

Price declines that are not based on company-specific fundamentals do not reflect the true value of a particular firm, and thus represent a market inefficiency we can exploit. We believe in long-term, buy-and-hold investing, and so we tend to view these pull-backs as opportunities for us and for like-minded investors to acquire shares at lower prices.

While we do take advantage of such volatility, we don't actually manage our portfolios to short-term factors. We focus not on what is important this month or this quarter, but on things that are fundamentally true, always -- things such as mitigating resource scarcity and adapting to the effects of climate change.

We believe our portfolios represent a good intersection of growth at a reasonable value, and the April/May pullback has only made that more true. For example, the average price-to-book ratio in our Sierra Club Green Alpha (SCGA) Portfolio is now 2.6, equal to that of the S&P500 at 2.64; and the weighted average earnings-per-share (EPS) growth rate (next 12 months) of the SCGA Portfolio is now 67 percent, where the SPX is 9.94 percent. So we've assembled a portfolio with 680 percent greater earnings growth than the S&P 500 index, but which simultaneously trades at the same price-to-book valuation as that benchmark. (Figures as of 5/14/2014, data from Thomson Reuters.)

In our mutual fund (ticker NEXTX), the picture is much the same. Here, the weighted average price-to-book ratio is 2.3, below that of the average S&P 500 stock, while NEXTX's EPS growth rate is 59.64 percent for the forward year, some six times faster growth than that offered by the S&P 500 average.

From this perspective, it's hard to see where the S&P 500 can be considered less risky than our fund, involving as it does investing in far slower-growing firms, and at richer valuations, than does NEXTX.

Risk vs. Uncertainty

Many people confuse and conflate these two terms but in reality, as in portfolio management, they actually mean different things.

Risk is quantified, measured; it uses numbers that exist today and can be crunched ten ways from Sunday. As such though, risk is necessarily backward-looking. Risk metrics can tell you all you need to know about how assets and portfolios performed in the past, and exactly what their "risk-adjusted" returns were. Risk gives you something quantitative and concrete to hang your hat on; it can be objectively analyzed without the need to make too many assumptions.

Uncertainty refers to what we don't know for sure about the present and can't know about the future.

For example, to cite a common area of risk measurement, I can tell you that through April 30 of 2014, the mutual fund rating agency Morningstar calculated that NEXTX had a trailing one-year upside capture of 149.96 percent, and a full-year downside capture of 69.71 percent, versus the S&P 500 total return. (Information from Morningstar.com) This means that over the past year, on an average day that the market was up, our fund performed approximately 50 percent better than the S&P 500, and on an average down market day, the fund was down only 69 percent as much as the index overall. As happy as I am with this trailing year result, it tells us very little about what results the fund may see in the coming year, or in any future period.

Uncertainty by its nature cannot be specifically measured. In our case, we look to invest in companies that our projections suggest will continue to grow rapidly because they have solid fundamentals and offer the most promising solutions to our most dangerous systemic threats. These companies are growing and will need to continue to grow at very rapid rates in order to be in any way commensurate with those threats. To illustrate, we know we are beginning to confront water scarcity, and we know we need far greater supplies of non-carbon-emitting energy. Do we know with certainty which companies addressing these concerns will have the best market performance? No. We are uncertain. But we do know that the world is rapidly mobilizing to address its systematic issues, and that the more attractively valued companies meeting the challenge of mitigating those issues will have far better than average growth potential.

Imagining, modeling, and building portfolios of firms that are leaders in offering improvements to economic efficiencies and sustainability frontiers is both far more interesting than exact but irreproducible risk numbers from the past and also far more likely to result in selection of stocks with the best chances of thriving into the future. We believe we have to concentrate on selecting the most innovative, adaptive firms able to embrace uncertainty. Measurable risk numbers -- occurring as they do in the past -- are no longer the most reliable tools.

Knowledge, innovation and technology are changing fast. A century ago, the totality of human knowledge was doubling every 100 years or so. Now, it's doubling every 13 months. Soon, according to some smart people at IBM, it may be doubling every 11 hours. The future will be nothing like the past. It's far better to proactively manage into the uncertainty of that future than it is to spend too much time reflecting on how great our risk metrics were. Last year.

To obtain a prospectus, visit www.sheltoncap.com or call (800) 955-9988. A prospectus should be read carefully before investing. Shelton Funds are distributed by RFS Partners, a member of FINRA and affiliate of Shelton Capital Management. Green Alpha Advisors is not affiliated with either RFS Partners or Shelton Capital Management. (04/2014)

[One of the most frequent questions we receive about our equity growth strategies, from both advisors and individuals, is "how would your mutual fund or separate account fit into my/my client's overall portfolio?" In this post, Green Alpha Partner and Senior Vice President Robert Muir puts the question in context and provides our views on the answers -- GJ.]

At Green Alpha Advisors, our first and foremost responsibility is, as a fiduciary; to represent the best interests of our separate account clients and mutual fund shareholders. Institutions, individuals, their consultants, and advisors entrust their hard-earned money to us. Our overriding mandate is to invest these dollars wisely and responsibly. It is precisely because of this mandate that our investment philosophy and thesis is focused firmly on economic and, by logical extension, environmental, sustainability. The only economically justifiable and responsible long-term investments we can make on behalf of our clients and ourselves are those allocated to the industries, companies, and innovations that will lead to the mitigation and eventual displacement of the untenable and globally disruptive business models that are the heritage of the industrial revolution. To us it is clear: The inefficient and unsustainable business practices of the obsolete fossil fuels-driven economy, characterized by the denial of disruptive and detrimental externalities, unchecked and exploitive use of resources and raw materials, and little to no waste to value economy, is a poor place to seek economic growth.

Green Alpha Advisors constructs portfolios of equities chosen from our proprietary universe of "Next Economy" companies -- those whose technologies, goods, and services are essential in the inevitable transition to a sustainable economy. The result of this thesis is that many Green Alpha Portfolios fall into the category of growth equity. Our most visible offering, the Shelton Green Alpha Fund (NEXTX), of which we are the sub-advisor, is categorized as mid-cap growth by Morningstar. Although the fund is in actuality all-cap, we were pleased to be ranked on 3/31/2014 the number one Mid-Cap Growth Fund - One Year3 by Morningstar, and the overall number one Large-Company Stock Fund – One Year5 by Kiplinger.

When constructing growth equity portfolios, we at Green Alpha Advisors look to our identified universe of public companies to select those equities that demonstrate what most analysts and stock pickers would consider emblematic growth characteristics. We identify fast-growing and emerging market sectors, often with high barriers to entry, and acquire shares in the firms that dominate these markets. We look for stocks that have posted steady historical earnings and revenue growth, preferably well above industry standards and, more importantly, which we judge will continue to demonstrate strong forward earnings and revenue growth. Many of our portfolio holdings are technology leaders and own proprietary intellectual property in patents and technologies that generate a consistent revenue stream from licensing fees and sales. We look for businesses with expanding profit margins, and we don't shy away from companies that, rather than paying out profits through dividends and stock buy-backs, are reinvesting those earnings to gain ever-greater market share and top-line growth. We expect efficient and innovative management, transparent and accepted accounting practices, and executives who keep a close eye on cost control and best use of revenue and earnings.

On top of our search to identify companies with strong growth characteristics, we also strive to incorporate into our stock-picking process traditional value-seeking methodologies. We look to purchase firms with consistent and predictable cash flows, defensible business models, and shares that trade at compelling valuations relative to both book and their overall industry. Additionally, we tend to benefit from the fact that many of the companies we follow are not yet heavily covered by the traditional analyst community. Often we identify undervalued equities before they gain the notice of the broader market, enabling us to enjoy the price momentum generated when these companies attract mainstream attention.

Stated plainly, one might say that, in terms of style, at Green Alpha we focus on growth -- and seek it at the best possible value1.

The Shelton Green Alpha Fund (NEXTX) exemplifies this investment approach. To illustrate, here are a few of the portfolio's characteristics as of 3/31/2014. On that date, NEXTX had a Price to Book ratio of 2.45 vs. 2.64 for the SPY2, a Price to Sales ratio of 1.53 vs. 1.67 for the SPY2, a Long Term Debt to Equity ratio of 0.41 vs. 0.75 for the SPY2, and a 12 Month Forward EPS Growth forecast of 38.12% vs. 9.31% for the SPY2.

While seeking exceptional growth at good value, we look carefully at overall portfolio construction, attempting to strike the optimum balance between risk and potential return, upside and downside capture ratios, and concentration versus. diversification. We keep turnover low to maintain tax efficiency, and we make every effort to provide a competitive expense ratio. Again, I'll use NEXTX as a case in point. The Fund, as of 3/31/2014, posted a trailing one-year total return of 56.09% vs. 21.86% for the SPX3, listed a beta of 1.35 vs. the benchmark SPX2, and had an upside capture ratio of 183.40, while the downside capture ratio was just 69.713. Thus the Fund achieved substantial alpha for only marginally higher than nominal beta, while affording exceptional upside participation along with broad downside protection. NEXTX currently contains 56 individual holdings, which are representative of 28 different industry sectors. From inception, 3/12/13, through fiscal year end 2013, the Fund expense ratio was 1.24%, 14 basis points lower than its capped limit of 1.38%, with a turnover rate of just 12%4.

We are pleased that many network and independent advisors have begun evaluating the Shelton Green Alpha Fund (NEXTX) as a growth equity holding suitable across all of their portfolio models, not solely those focused on "green," "SRI," or "impact" investing. This consideration has brought with it the inevitable question: What percentage allocation do we deem appropriate for NEXTX? Aware that every investment model and client portfolio has different investment parameters and objectives, we hesitate to offer specific weightings or allocations. However, we will state that we believe the NEXTX is a high-quality, non-correlative portfolio appropriate as a core equity holding suitable for a material portion of an overall growth equity allocation. Green Alpha Advisors remains committed to sustainable, fossil fuel-free investing, and we are honored by the advisor community's recognition of NEXTX as a highly competitive product that brings an added level of diversification to any equity investment model.

To obtain a prospectus, visit www.sheltoncap.com or call (800) 955-9988. A prospectus should be read carefully before investing. Shelton Funds are distributed by RFS Partners, a member of FINRA and affiliate of Shelton Capital Management. Green Alpha Advisors is not affiliated with either RFS Partners or Shelton Capital management.

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